With End of Year Looming, It's Time To Prepare For Year-End Statements

By Jim Jordan

With the end of 2005 looming hard on the horizon, it's time for contractors to begin thinking about their year-end financial statements. It's these statements, after all, that determine whether surety companies and banks continue to have confidence in a contractor's ability to manage his or her operations and show a profit.

Jim Jordan is director of construction services for Dallas/Fort Worth-based Weaver and Tidwell LLP.

For a privately owned company, and most contractors are privately held, the process should begin with company owners looking first at their personal finances. With the help of a CPA, owners should make certain their finances can be presented in a timely, accurate and favorable fashion. This is important because surety companies often require owners of privately held businesses to personally guarantee bond lines. Therefore, personal statements actually support the company and should include pertinent information on personal mortgages, investments, bank accounts, credit cards bills, loans to family, auto loans and such. It is especially important in the preparation of personal financial statements that any financial transactions with the company are shown on both the personal statement and company statement.

Before tackling company statements, however, there's always homework to be done. This is where a CPA who specializes in construction accounting can provide the necessary guidance. Your CPA can determine whether there have been any recent changes to tax laws or accounting principles that impact your company. This year, for example, one of the biggest changes affecting contractors' financial statements is FIN 46, a new interpretation issued by the Financial Accounting Standards Board.

FIN 46 is a new accounting principle, not a law. Prior to this updated interpretation, a company was expected to show on its financial statements any outside entity in which it held a majority of the voting interests. FIN 46, however, extends the requirement to include variable interest entities, or VIEs. These are defined as "any legal structure used to conduct activities or hold assets,'' and include non-market-driven leases; certain service contracts; forward contracts to buy or sell assets, guarantees of another entity's assets, subordinated debt, and swaps or other derivatives.

FIN 46 is complex and may have a significant impact on a company's financials. You should seek your CPA's advice in applying and interpreting FIN 46.

Before year's end, company owners should also focus on getting all change orders signed. Having change orders signed, particularly those that are material to your financial statements, will help eliminate reporting problems. Your CPA will look hard at unsigned change orders to ensure they are properly recorded in accordance with generally accepted accounting principles. Signed change orders not only protect you and your right to get paid, but also help produce accurate financial statements.

In addition to getting change orders signed, there are other steps you can take to bolster working capital before the end of the year. They include:

Postponing major purchases Particularly toward the end of the year, owners should consider postponing the purchase of any large assets until after the first of the year. A general rule of thumb is to keep the debt-to-equity ratio under 3 to 1, and the interest-bearing debt-to-equity ratio under 1 to 1. Alternatively, you may want to consider leasing equipment rather than buying it if there isn't ample working capital.

Managing cash The cleanest end-of-year statements are those that avoid negative cash at year's end. Owners should avoid writing checks at year's end in anticipation of receivables that will come in the next week. Instead, they should issue checks in the new year.

Showing low inventory Because bond underwriters usually discount inventory by 50 percent, contractors should try to have the lowest inventory at the end of the fiscal year. Also, if inventory turns over numerous times, sureties should be informed of that so the discounting can be favorably modified.

Stockholder repayments Issuing bonuses to senior executives is always preferable to giving them a loan. Shareholder loans make bond underwriters question a company's overall financial acumen. The underwriters may treat such loans as a reduction of capital if the amounts are large or have been outstanding for a long period of time. Consequently, all loans to company stockholders or officers should be repaid by year's end.

Underbillings At year's end, contractors should have all jobs properly billed. A significant amount of underbillings raises red flags with sureties and lenders, who want low underbillings and receivables less than 90 days old. It's also important to bill retainage as soon as possible. These steps demonstrate you are actually managing cash flow.

Listing life insurance Sureties usually consider the cash value of life insurance as a source of working capital. With help from a CPA, contractors can show the cash value on their balance sheets as "other assets,'' which improves the overall amount of working capital.

These strategies for producing effective year-end financial statements are fundamentals that should be enacted throughout the year, not just in the final quarter. Owners who stay on top of their financial accounting all year will be able to avoid costly mistakes and omissions that invariably occur during an end-of-year rush. It's important to avoid these problems because end-of-year statements serve more than one purpose: More than just financial documents, they can shed favorable light on a company's processes. Well-organized, proactive statements that demonstrate financial health always instill confidence in the lenders and bond underwriters who decide a contractor's future. These year-end statements, however, can be difficult to produce in the eleventh hour. If the year-end rush is beginning at your firm, remember to get started earlier in 2006, and get help from your CPA.